Simple Steps You Can Take Right Now To Trade Volatility ...€¦ · •Index iron condors are the...
Transcript of Simple Steps You Can Take Right Now To Trade Volatility ...€¦ · •Index iron condors are the...
Simple Steps You Can Take Right Now To Trade Volatility
Like A Pro Jay Soloff
Options Portfolio Manager
Editor – Options Profit Engine, 30 Day Dividends
About Me
• 20 years of experience trading options
• 8 years of online research & options services
• CBOE floor trader and market maker – provided liquidity on the largest options exchange in the world for stocks like Amazon
• Hedge fund analyst, options portfolio
• MBA, MSIM, Arizona State University
• BA Economics, University of Illinois
Options Trading Online Resources
• Marketchameleon.com (analytics, screener)
• Cmlviz.com (backtesting)
• Cboe.com (videos, education)
• Optionseducation.org (education)
• Vixcentral.com (volatility)
• Sixfigureinvesting.com (volatility)
Volatility Is Not Always Where You Expect
*https://www.marketwatch.com/story/whats-more-volatile-than-bitcoin-you-may-be-surprised-2018-10-22
What Is Options Volatility?
• Despite the previous chart, when we talk about options volatility, we are generally referring to implied volatility
• Implied volatility measures the expected rate of change of a stock price (or any other underlying asset) • Expressed as a percentage (annualized version of standard deviation of daily price moves)
• Better seen as an example – so if Coca-Cola (KO) has a 11% implied volatility, it’s expected to move 11% up or down over the next year
• Compare KO to Tesla (TSLA), considered a more volatile stock, which has an implied volatility of 57%
• For SPY, the S&P 500 ETF, October IV got up to 22% from about 9% in September. For reference, the HV for SPY peaked at around 23% (it was 7% at the end of September)
Why Trade Volatility?
• Volatility tends to be more predictable than asset prices (despite what happened in February and after)
• It has mean reverting characteristics (statistical evidence)
• It’s relatively easy to trade volatility with options or ETPs (not quite so much at the moment with ETPs – though that could change)
• My favorite way to sell volatility is with iron condors, although there are many different ways to do so
Step 1: Follow Volatility Metrics
• Keep an eye on the VIX and how its price compares to past levels • The VIX is the S&P 500 Implied Volatility Index (more in a minute)
• The VIX isn’t the perfect indicator of market volatility but it does a good job for what it is – and it’s easy to find and compare to past data • Remember, it only measures the S&P 500 implied volatility
• VIX can be a signal of a major upcoming move in the market • It can help show you when to increase hedging
• It can also be a decent indicator of “all clear”
What Is The VIX?
• The calculation isn’t important • It’s a measure of 30-day implied volatility, so
it’s what the market expects to happen Here’s why the VIX is important: • As more people buy options, the VIX goes up • Investors tend to buy options when they are
worried (especially to the downside) so the VIX goes up when investors are worried
• That’s why it is commonly knows as the investor “fear gauge”
• It’s a major source of hedging by institutions and funds
More About The VIX
• The VIX itself isn’t tradeable, only futures, options, and ETPs
• Volatility ETPs are very popular (but none truly replicate the VIX) • VXX (short-term futures) – the most popular
• XIV (inverse)
• SVXY (from -1x to -.5x)
• TVIX (leveraged 2x, no options)
• UVXY (from 2x to 1.5x)
• VXZ (medium-term)
• Everything in the market goes in cycles, and no doubt these products will once again grow in number
Step 2: Selling Volatility Is Still Good
• It’s true despite the two big volatility events we’ve had in 2018 (February and October)
• I mentioned before the volatility has mean reverting characteristics, and it’s very apparent with the VIX • The VIX is normally low • When it spikes, it tends to come back down quickly (unless there’s a major
dislocation – see February 5th) • VIX up days tend to be infrequent and spread out
• Magnitude is larger than down days in most cases
• VIX down days are the norm and usually occur in bunches • It’s important to stay away from the short volatility strategy when there is a
lot of uncertainty in the market (politics, Fed, etc.)
Why It’s Usually Better To Sell Volatility
Why It’s Usually Better To Sell Volatility Part 2
Quick Definition: Delta
• For my upcoming trading strategies and examples, I talk a lot about delta.
• Delta tells you how much an option price will move in relation to the underlying, so for example a 50 delta option will move $0.50 for every $1 move in the underlying asset
• Delta gives you a rough probability of the option finishing in the money, so a 50 delta options has about a 50% chance of ending up in the money, 30 delta/30% and so on
• 50 delta options are at the money, below 50 are out of the money, and those are the options we usually deal with.
Shorting Market Volatility: Results Bottom line: Using the widely popular VXX ETN (short-term VIX), you would have made money over the last five years buying puts or selling call spreads
Selling Volatility: Disclaimer
• I wrote this before February 5th and the aftermath and now we’ve had another volatile month in October
• Keep in mind, funds use the VIX to hedge, so there will always be demand for long VIX
• However, don’t forget, the VIX can move up in a hurry when the market starts to worry • Huge gaps can occur and you may not have time to exit positions
• Always be aware of the macro environment • Try not to go short volatility through major events (like elections/FOMC uncertainty)
• The ETP blowup in February was unforeseen but the political drama is more predictable
Step 3: Follow The Implied Volatility
• Market volatility (VIX) isn’t the only way to trade volatility
• Every stock, index, ETF, commodity, currency, bond, etc. has its own implied volatility curve you can look at and use to make trade decisions
• For most any asset, implied volatility will also revert to the mean
• Single stocks have more volatility buying opportunities than index ETFs due to earnings, but both tend to mean revert. • AAPL versus SPY
AAPL Implied Volatility Curve
SPY Implied Volatility Curve
How To Sell Volatility In Equities
• Unlike with the VIX, there isn’t an ETP available for individual stocks or ETFs
• As such, you have to use options to sell volatility
• My favorite way to sell volatility is using iron condors, which limits risk and margin requirements
What’s An Iron Condor?
• An iron condor is simply selling an OTM call spread and an OTM put spread in the same expiration • The goal is pick a range you expect the underlying asset to remain in
• Index iron condors are the most popular to sell but they can be used in just about any underlying asset • Indices/ETFs like SPX and SPY are the most popular underlying assets for
trading iron condors • I like using expensive (price level) tech stocks
• You want your underlying to be more volatile than normal, but not too volatile. • Low volatility assets don’t have enough juice in the options • The same is true for low priced stocks/ETFs
Iron Condor Example
• You expect Adobe (ADBE) to stay in range ($60) over the next 40 days
• Implied volatility is over 35% with the IV 20-day moving average at 25% (and no earnings prior to expiration)
Selling Volatility: Iron Condor Results
Summary
• Keep an eye on the VIX • Understand its limitations
• Selling volatility has a high probability of success • Know the risks
• You can trade individual equities by following implied volatility • Compare current implied volatility to the average
• Iron condors are a very good way to trade volatility as long as the right conditions are met
Bonus Training
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